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Saturday, October 6, 2012

The more common a term becomes, the more it is taken for granted and the less it is subjected to criticism. A case in point is the term “free trade”. These two words are so frequently seen next to each other, that little thought is given to what they really mean together. Is it reasonable to talk of “free” trade?

Trade is usually said to be “free” from an economic point of view, namely when there are no tariffs or subsidies that hinder or otherwise distort trade. With this definition there is clearly little “free” trade between nations, because most world trade is regulated by bilateral trade agreements which are not “free” in this sense. For instance, despite its name the so-called “North American Free Trade Agreement” (NAFTA) is not “free” since it defines tariffs on many goods that are exported and imported between the Canada, Mexico, and the United States.[1]In this conventional definition, therefore, “free trade” is a term that does not describe the real world, since international trade often does not meet these conditions. But it is possible to go further, because even in the rare occasions when these economic conditions are fullfilled, like within the European Union for instance, there are fundamental political reasons why trade still should not be called “free”.

Trade between nations cannot, in principle, be “free” if this word is considered in its negative meaning of “absence of constraints.”[2] Trade between two individuals can be called “free” if both these individuals are lucid and informed, consenting to trade with each other under fair rules, and no pressure is exerted by one over the other, or by any third party on either of them. From a philosophical point of view, this is of course never the case; an individual is always constrained, if only for biological reasons. But politically, and for all practical purposes, it can be said that there are conditions in which two such individuals can engage in “free” exchange. However, this is not true for trade between nations, because nations are not like individuals, for two main reasons.

Firstly, nation-states are far more complex than individuals. Unlike individuals, they must take into account myriad internal factors. Nations are constrained by innumerable domestic affairs which prevent them from trading “freely” with the rest of the world. To this argument it might of course be objected that government administrations largely act independently of the will of the people, even in democracies, especially with regard to international relations. Foreign and trade policy in particular traditionally transcends party lines; all parliaments, governments and high courts, regardless of their composition, are understandably committed to defending their countries’ particular interests on the international stage. Can anyone seriously state, for instance, that the people, whether in the developed or in the developing world, have had much influence on the WTO trade negotiations that have been going on for several decades? On the contrary, such decisions are often made on behalf of the nation by a small group of civil servants. Modern nations are usually governed by bureaucracies rather than by elected representatives of the people.

Nevertheless, despite these important objections, it does not seem possible to equate nations with individuals. A country’s public opinion and poll results cannot be entirely dismissed by government administrations, in particular when trade policy is seen as affecting local economies at home. Bureaucracies responsible for negotiating and setting trade policy cannot act entirely independently of society because they must take into account many different interest groups of varying degrees of influence. Nations are not atomic entities; unlike individuals, they are incapable of making politically independent and unconstrained decisions, not least with respect to trade. Thus, international trade should not called “free” because nations, as opposed to individuals, are obliged to consider numerous, often contradictory, claims and requests from a variety of sources when making decisions regarding trade.

The second reason world trade should not be called “free” is because the current international order is unjust. Political freedom, whether among individuals or nations, requires the rule of law. Since there is, to this day, no comprehensive and impartial international jurisprudence to which all nations are equally bound, trade can only really be “free” between equal nations; whose interests are aligned and complementary. Besides the obvious difficulty of assessing whether this is ever the case, the extreme diversity of nations makes such a situation unlikely. When nations are unequal, as is usually the case, when one is stronger than the other economically or militarily, trade becomes skewed. (In extremis, when one nation is far superior to the other, trade becomes a tribute payed by the weaker nation to the stronger one, such as often happened in feudal times.) Nations tend to interact with each other as individuals do in a “mafia” environment; that is, where “might makes right.” In such an environment, stronger nations naturally benefit more than weaker ones from trade, since they more easily impose their demands and obtain more favourable trade terms. In current times, the United States, by far the world’s biggest military and economic power, most enjoys such an advantageous trade position.

Thus, to sum up the preceding points, trade cannot be called “free” from a political perspective because nation-states are not like individuals, who in many circumstances are able to trade freely with each other. Firstly, nations have internal constraints that individuals do not. Secondly, nations are far from operating in the same kind of legal environment as citizens of modern nation-states. Freedom is first of all a political concept; “free” trade should therefore be defined not only economically as in the standard definition above, but also politically. These political considerations for international trade will now be illustrated using both historical and contemporary examples.

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The 19th century after the defeat of Napoleon is often described as a time of “free” trade during which a benign Pax Britannica reigned over the world and assured the peaceful and “free” exchange of goods between all countries. Strong reservations must be made, however, regarding such a statement. The world was largely divided between a few big European powers and only a handful of countries were actually engaged in international trade; most other regions were trading on terms dictated by their colonial masters. At that time, trade was also far smaller than today; it has been estimated that international trade represented only one percent of global wealth in the 19th century whereas today it amounts to more than 40 percent of world GDP. In comparison with the XXIst century, nation-states were then largely autarkic and world trade could therefore hardly be called “free” from any meaningful point of view.

Britain’s colonial domination and her control of the sea routes during this period assured favourable terms for the export of British goods. For instance, from the end of the 18th century the British started to demand that India give up the production of cotton and instead import finished textiles from Britain.[3] The raw cotton was then sent to England where it was made into cloth in the mills of Manchester and Lancashire, before being shipped back and sold in India.[5] This decision was as beneficial to England’s industrialisation as it was detrimental to India’s development. So advantageous was this state of affairs for the United Kingdom that India was not allowed to set tariffs on cotton goods until 1917.[4] This is an example of how the stronger trading partner tends to benefit more from trade than the weaker one.

David Ricardo’s famous example of the trade of Portuguese wine for English wool should also be seen in this context. It is an interesting example since it has been used by economists to prove that “free” bilateral trade is beneficial for both countries when based on natural comparative advantages. However, economists often lack an understanding of history and politics. It is essential to have an idea of the geopolitical situation between Britain and the Iberian Peninsula in order to understand the actual trade relations between these countries. In fact, the progressive British military ascendancy over Portugal and Spain in 17th and 18th centuries gradually led, as expected, to tangible commercial benefits for Britain. Writer and journalist Eduardo Galeano wrote the following in his now classic work on the political and economic history of Latin America:

“Gold began to flow [from Brazil to England] at the same moment Portugal signed the treaty of Methuen, in 1703, with England. This was the coronation of a long series of privileges obtained by British merchants in Portugal. In exchange for her wines for the English market, Portugal was to open her own market and its colonies to British manufactured goods. Given the level of industrial development which existed at the time in Portugal, this measure meant the ruin of local manufacturing. It was not with wine that English cloth was to be bought, but with gold from Brazil, and as a consequence the nascent cloth industry of Portugal was paralysed. Portugal not only nipped in the bud its own industry but also destroyed the seeds for any other industrial development in Brazil. The kingdom prohibited the operation of sugar refineries in 1715; in 1729 it declared a crime the opening of new roads of communication in the mining region; in 1785, it ordered the burning of the Brazilian textile and thread mills.”[6]

This example of Spain and Portugal (and their former colonies) shows that to allow the unconditional import of goods from more developed countries can have disastrous social consequences that can last for centuries. Indeed, the value of the exports of these two countries still remains relatively small in the XXIst century. The Methuen treaty was evidently not a trade agreement between two equal partners within a system of rule of law, and can therefore not be considered “free” trade. England was able to industrialise partly at the expense of the development of Spain, Portugal, and its colonies, by making full use of a favourable balance of power with these countries.[7]

These historical examples are interesting because they clearly show to what extent nations try to turn political and military advantages into commercial ones. It is a general rule that should be evident to any honest student of international relations; namely that trade agreements are generally skewed by the political situation in which the trading partners find themselves at a given time. This is still the case today of course, though the modern world adds a layer of complexity. It is well known that most of the high value goods that are traded today depend only on conditions that can be acquired (such as education and infrastructure). However, the acquisition of these conditions is often difficult and costly. The high barriers to entry of many industries, such as the automobile or the pharmaceutical industries, means that it is important today not only to have a favourable geopolitical position, but also to be the first in as many sectors as possible. As a result, though the modern world creates significant opportunities, in this sense it also tends to entrench the political status quo. This “first mover advantage” helps to maintain the historical power relations between stronger and weaker nations, i.e. the intractable split between the North and the South.

A consequence of this idea is that protectionism can be recommended in the modern world. Indeed, “Global Trade and Conflicting National Interests”, an important work from 2000 by Professors R. E. Gomory and W. J. Baumol, supports this conclusion. They found that though some bilateral trade can be beneficial for both nations, there are many trade scenarios in which the national interests of two countries conflict with one another. The authors noted that, “It is often true that improvement in one country’s productive capabilities is attained only at the expense of another country’s general welfare.”[8] Using mathematical modelling, the authors showed what can often be grasped intuitively, namely that trade does not always benefit all involved parties. A nation may be worse off if it increases trade with a more industrialised and developed trading partner, rather than trying to limit its trade with this partner.

It can thus be in the interest of the weaker countries of the world to engage in protectionism. Protecting nascent industries and promoting their development until they are competitive enough to compete at internationally, may be a good strategy in some cases for emerging and undeveloped nations. On the other hand, this is precisely the reason why the deregulation of trade is generally supported by the richest and most developed countries. Indeed, the biggest proponents of “free” trade have long been the West; those nations which, due to their positions of relative economic and political strength with the rest of the world, have been (at least until recently) in the best position to profit from increased international trade.

The West, though, hasn’t always been so enthusiastic about global trade. The economist Ha-Joon Chang described in his excellent study, Kicking Away the Ladder, how trade policies of Western nations have changed significantly over time. The same countries that today officially support “free” trade all used protectionist measures in the past, when they deemed that their own recently founded industries had to be protected against foreign, and in particular British, competition. This was precisely the way in which for instance Germany and the USA were able to build up an industrial economy and become internationally competitive. As Chang wrote, “between the Civil War and the Second World War, the USA was literally the most heavily protected economy in the world.”[9] It should not be surprising, therefore, that the first support for “free” trade originated with British economists, such as Adam Smith and David Ricardo.

The European Union presents an interesting example in this discussion, since it is a historically rare case of unregulated trade between nations at very different stages of social and industrial development. The unhindered movement of goods and services within the European Union has enabled the strongest powers among the 27 EU members, in particular Germany, to benefit hugely from trade with the weaker and less developed ones. Germany has enjoyed huge current account surpluses, partly at the expense of other European countries which predictably have suffered from weak industrial output, large trade deficits and high levels of debt. The “free” trade environment in the EU has been beneficial mostly to the stronger nations, and has helped reestablish Germany as the dominant power in the region. As expected, for the weaker EU nations it is certainly far from clear that the increased “free” trade with Germany has had positive long term effects, in particular considering the major economic difficulties that they now are facing.[10]

Though the most developed nations understandably promote unregulated trade, at the same time they also discreetly contribute to distorting and regulating trade when they want to protect their own industries. Such protective measures include tariffs, of course, such as the EU and US tariffs on Chinese goods.[11] Subsidies are also a common tool used to distort trade when these nations cannot compete on price. Agriculture is a good example; the EU and the US have been heavily subsidising their agricultural sectors for decades. The Common Agricultural Policy, which subsidises European agriculture, consists of almost half of the entire budget of the EU, or around 50 billions euros per year.[12] Similar protection is given by the United States to its cotton and corn industries, both receiving billions dollars per year in subsidies. These policies have the effect of distorting world market prices and of denying access to Western markets for many of the world’s poor and emerging countries. In the name of “free” trade however, the EU and the US continue to demand that other countries, usually poorer ones, open up their markets to Western investment and trade. This is the main reason the latest “Doha” round of WTO trade negotiations has stalled for years.

The consequences of such trade policies can be devastating for weaker nations. In a surprisingly candid moment, former US president Bill Clinton confirmed in a mea culpa appearance in the Senate Foreign Relations Committee in March 2010 that he had sacrificed the future of the Haitian society for the sake of US interests.[13] He confessed that, as president, he had deliberately chosen to give in to the demands of the rice farmers of his home state of Arkansas, as well as the IMF and World Bank, “conditioning access to foreign aid on Haiti dramatically cut its trade tariffs on imported US rice”. The customs duties that had protected Haiti’s domestic rice production were reduced from 50% to 3%. Not surprisingly, this trade policy decision by the Clinton Administration fatally undermined Haitian agriculture, made Haiti even more dependent on imported food and strongly contributed to the social and economic catastrophe that Haiti has been experiencing for the last decades.[14]

Despite what is often heard, therefore, “free trade” is an illusion. Trade is not “free”, neither from an economic nor from a political point of view. The reason for this lies not in the nature of international trade, but in the nature of the agents who engage in it. Nation-states do not trade “freely” with each other not only because it is not in their interest, but because they are inherently incapable of doing so. It is therefore utopian of the United Nations to wish for “a universal, rule-based, open, non-discriminatory and equitable multilateral trading system”[15], since, on the contrary, international trade between nation-states tends to be specific, discriminatory and inequitable. To claim that world trade is, or should be, “free” is an idea that has been promoted by the most developed nations. These countries support a largely unregulated international trade system under which tariffs and subsidies are acceptable only if they are in the interest of these very countries. This is the reality of international trade.

Notes:

[1] See, for instance, Mexico under NAFTA, by Timothy A. Wise, Director of the Research and Policy Program at the Global Development and Environment Institute, Tufts University.

[2] For a review of positive and negative liberty, see the classic essay from Isaiah Berlin, in “Four Essays on Liberty”.

[4] As T. S. Ashton wrote in Standard of Life of the Workers in England: "Instead of producing muslins, cambrics, and other goods of high quality for sale in Europe and in the United States, the factories of Lancashire were increasingly concerned with cheap caliceos for Indian and Far Eastern markets.", in Capitalism and the Historians, p136, by F. A. Hayek, editor.

[6] E. Galeano, Las Venas Abiertas de América Latina, Siglo XXI de España Editores. The Treaty of Methuen was a military and commercial treaty signed between England and Portugal, which stipulated that no tax could be charged for Portuguese wines exported to England or English textiles exported to Portugal.

[9] For instance: “The United States maintained weighted average tariffs on manufactured products of approximately 40–50% up until the 1950s, augmented by the natural protectionism of high transportation costs in the 19th century, “Kicking Away the Ladder”, p 17. See also, Ha-Joon Chang, “Kicking Away the Ladder”, post-autistic economics review, issue no. 15, September 4, 2002, article 3. http://www.btinternet.com/~pae_news/review/issue15.htm

[12] EU statement: “The overall cost to the European Union is about €53 billion а year. This is roughly 40% of the total EU budget. The CAP's share of this budget is constantly shrinking: from 71% in 1984 to an expected 39% in 2013.” (http://ec.europa.eu/agriculture/faq/cost/index_en.htm)

[14] Mr Clinton’s exact words in the Senate hearing were the following: “I have to live every day with the consequences of a decision of mine which may have been good for some of my farmers in Arkansas, but it has not worked. It was a mistake. I had to live everyday with the consequences of the loss of capacity to produce a rice crop in Haiti to feed those people because of what I did; nobody else.” See Education International website, Impacts of IMF Policies on National Education Budgets and Teachers, Richard Rowden, Education International Research Institute, July 2011. http://download.ei-ie.org/Docs/WebDepot/EI%20Study%20on%20IMF%20Policies%20and%20Alternatives.pdf